Equities: Germany – tailwind from stimulus plan

Last week, Germany announced an unprecedented fiscal package aimed at bolstering defence and infrastructure spending, which consists of three key parts: a EUR 500bn budget infrastructure fund over the next decade, exemption of defence expenditures exceeding 1% of GDP from the constitutional debt brake, and an increase in the allowable structural deficit.

These measures require constitutional amendments and a two-thirds majority in parliament. They are expected to benefit aerospace and defence companies, as well as German domestic stocks, particularly those represented by the MDAX Index, which we favour due to its cyclical nature and relatively attractive valuation compared to the DAX Index. The MDAX shows 38% revenue exposure domestically versus only 18% for the DAX Index, so it is better positioned for stronger domestic demand from a potential acceleration in economic growth. Mid-caps also have a heavier index weight in industrials and materials (42% vs 31% in the DAX) – sectors that may benefit the most from investments in transportation, energy grids, and housing.

Consensus expectations indicate nearly 8% earnings growth in 2025 for German large-caps, outpacing their European peers. Moreover, there are potential benefits from improved economic activity in China or reduced gas prices resulting from a potential ceasefire agreement in Ukraine. Hence, we maintain a bullish outlook on German equities, driven by attractive valuations and the European Central Bank’s accommodative monetary policy. 

Fixed income: Historic moves after Germany’s U-turn

The EUR bond market showed historic moves following Germany’s proposed plans to ramp up infrastructure and defence spending, with a 30bps move in the 10-year German Bund yield last Wednesday (5 March). Key measures include a EUR500bn infrastructure fund (spread over ten years) and a more relaxed definition of the debt brake when it comes to defence spending. All in all, if this goes through parliament and if Germany were to make full use of the newly created fiscal space, this could result in an additional yearly government budget deficit of up to 2.5%–3% of GDP, which is sizeable. Certainly, there are still a lot of unknowns, and operational constraints will likely be a limiting factor in the implementation, such that the fiscal deficit will likely grow in a more gradual way.

However, from a credit perspective, it is important to note that Germany definitely has the fiscal room to implement this plan, and it should not materially deteriorate Germany’s credit profile. In fact, credible growth-enhancing measures could even improve the outlook. Even if the debt/GDP ratio might rise from the current 63% towards 80% by the end of the decade, it is still well below the G7 median of 115%. Moreover, interest expenses are very low, and debt affordability metrics should remain strong.

What does this mean for investors?

We acknowledge the policy pivot in Europe and have upgraded the MDAX Index as a German proxy that is closer to home than the DAX (which we still like). We also think that core eurozone bond yields are attractive in real terms after last week’s historic move. There are still a lot of unknowns however, so we would not make any drastic changes in fixed income portfolios.

Our preference for cyclical exposure aligns with the DAX’s composition, and the MDAX is poised to benefit from the fiscal stimulus, underscoring a significant recovery in earnings momentum and a promising outlook for the market.